While the Assessing Officer (AO) rejected her claim, treating mutual fund units as equivalent to shares of Indian companies and attempted to tax the entire amount, the ITAT contended that mutual funds in India are created as trusts and not companies under SEBI regulations. Since the term “share” is not defined in the DTAA, and mutual fund units are not treated as shares under the Companies Act, and hence cannot be taxed.
Implications of the judgment
This judgment not only impacts NRIs in Singapore but could also influence similar cases involving non-residents in countries like Switzerland and the UAE with DTAAs in place. The ruling reinforces the distinction between mutual fund units and equity shares in tax treatment.
The ITAT judgment effectively makes capital gains from Indian mutual funds tax free for NRIs in countries like UAE and Singapore, which do not impose capital gains tax.
“This is about India's Double Taxation Avoidance Agreements (DTAAs) with countries like the UAE, Singapore, Mauritius, and Portugal which exempt these capital gains on mutual fund investments as it gives the taxing rights to the country of the investor’s tax residency,” says Yeeshu Sehgal, head of tax markets, AKM Global, a tax and consulting firm.
This, he adds, is advantageous for NRIs residing in jurisdictions that do not levy capital gains tax at all, such as the UAE.
According to Nilesh Shah, managing director, Kotak Mahindra AMC, the ITAT decision has the potential of incentivising Indian citizens to shift tax residency and save on capital gains tax liability on MF units.
“Obviously, this cannot be done by a large set of MF investors. Only a few super HNIs will do it. Already we have seen people migrating to UAE and Singapore. This will give one more incentive for such migration,” says Shah.
Fearing that this provision will be abused by seasonal non-residents, Shah suggests the government should ensure that tax is paid in the host country where income is generated and credit is taken in the reciprocal country if the same income is getting taxes in that country so that double taxation is avoided.
“If we have to persist with tax benefits for larger causes, they should only be available to foreign citizens and not to seasonal non-residents," he adds.
However, availing this benefit is subject to obtaining valid tax residency certificates.
Yeshu of AKM Global says: “One needs to be careful on getting the TRC as well since in places like UAE, there are two types of TRCs available -- one for the domestic law and one for taking DTAA benefit and sometimes the TRC process is time consuming so planning in advance is the key.
Taxes in India
In India, any capital gains from debt mutual funds are taxed at an individual’s slab rates. In case of equities, short-term capital gains from equity mutual funds are taxed at 20%, while long-term capital gains are taxed at 12.5% if the gains are over Rs 1.25 lakh.
“Let us give a fair, level playing field to both honest, tax-paying citizens of India and non-resident Indians. The loophole needs to be plugged,” feels Nilesh Shah of Kotak Mahindra AMC.
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